RBI faces tough task in policy review amid leadership uncertainty, economic strains

With uncertainty surrounding the extension of Reserve Bank of India (RBI) Governor Shaktikanta Das’ tenure, the central bank faces a challenging backdrop as its Monetary Policy Committee (MPC) prepares to announce its crucial repo rate decision on Friday (December 6). Depending on the policy decisions made, this could translate into potential changes in the cost of loans and overall economic conditions for the common man.

Recent economic indicators paint a grim picture. The GDP growth rate has slumped to 5.4 per cent for the July-September quarter, the lowest in seven quarters. Meanwhile, inflation surged to 6.2 per cent in October, breaching the RBI’s upper tolerance limit of 6 per cent. Compounding these challenges is a sharp depreciation of the rupee, which has lost nearly 1 per cent against the dollar since October 1.

The RBI has been actively selling dollars to stabilise the rupee and manage market volatility, resulting in a $45 billion reduction in forex reserves between October 4 and November 22.

Also read: Indian economy well-positioned to handle global spillovers: RBI Governor

Liquidity deficit

This aggressive intervention has tightened liquidity in the banking system, a problem likely to worsen in December due to advance tax and GST payments and increased credit demand at the quarter’s end. The liquidity deficit is expected to deepen without corrective action from the RBI.

One possible tool the RBI might use is to cut the Cash Reserve Ratio (CRR), which is the portion of deposits banks must keep with the RBI. If the CRR is reduced by 50 basis points, it would release ₹1.1 to ₹1.2 lakh crore into the banking system. A 25-basis-point cut would release half that amount. This extra liquidity could encourage banks to lend more, potentially boosting economic activity.

The RBI could also continue its open market operations (OMO) (to regulate liquidity in the banking system by buying or selling government securities in the open market) to buy back government bonds, injecting liquidity into the system.

“There have been a lot of dollar sales (by the RBI), which has affected the overall liquidity in the system. In December, liquidity will further tighten due to outflows related to payment of advance tax, goods and services tax (GST), and quarter-end demand for credit. Under this situation, a permanent measure can be announced (by the RBI), which could be a CRR cut or OMO purchase,” said Madan Sabnavis, Chief Economist, Bank of Baroda.

Repo rate

The repo rate, currently at 6.5 per cent, is unlikely to be changed. Lowering it might make borrowing cheaper, but it could weaken the rupee further and make imports more expensive, worsening inflation. With uncertain global conditions, the RBI is expected to maintain this rate.

“Even as the RBI’s growth/inflation forecast will see significant downward/upward revisions, an immediate rate cut may not be easy for the MPC to justify, especially as their commentary has been assertive on durable disinflation (durable disinflation is the sustained reduction of inflation to a stable, manageable level over time, ensuring long-term economic stability and predictability) being the primary mandate. Nonetheless, the pressure on convention easing will only mount as growth looks structurally pale. The timing and window of cuts are tricky and small amid fluid global dynamics, while the RBI may also want to weigh the forex cost of rate cuts,” Emkay Research said in a note to investors.

Also read: WPI inflation rises to 4-month high of 2.36% in Oct, food prices spike

How does this affect you?

Loans and EMIs: If the CRR is cut, banks might lower lending rates, making home, car, and personal loans cheaper. This is particularly significant at year-end when people often make big purchases.

Savings: Reduced interest rates mean lower returns on fixed deposits and savings accounts.|

Inflation: If the measures help stabilise the rupee, imported goods like fuel might become cheaper, easing inflation.

Economic growth: Easier access to loans could spur businesses and individuals to spend and invest, improving job prospects and incomes.

“A CRR cut will free up bank money, which can further be deployed for lending. There is a chance that banks may pass on the benefits of this CRR cut to borrowers. Usually, the cut in CRR is net interest margin (NIM) accretive for banks,” a report quoting VRC Reddy, Head Treasury, Karur Vysya Bank, said.

The RBI’s actions aim to balance controlling inflation and reviving growth. While the repo rate might stay unchanged, measures like a CRR cut or OMOs could provide much-needed relief for businesses and consumers. For the common man, it means staying alert to changes in borrowing costs and market conditions as the RBI navigates these tricky waters.